On September 1, 2020 the IRS and the Department of the Treasury released final regulations for Section 59A – the base erosion and anti-abuse tax (BEAT), providing additional guidance on its application.
What changes were made to the final regulations?
The final regulations generally retain the basic framework and approach of the proposed regulations with certain modifications or clarifications related to the following items:
- Determination of a taxpayer’s aggregate group, with specific changes are related to:
- Rules relating to the determination of gross receipts and the base erosion percentage for a short taxable year
- Members leaving and joining an aggregate group
- Aggregate Group Members with Different Taxable Years Leading to Over-and Under-Counting of Gross Receipts
- Predecessors and successors
- Election to waive allowable deductions, with specific changes are related to:
- Eligibility for the BEAT waiver election
- Waiver of life and non-life reinsurance premiums
- Partial waivers
- Application of the BEAT waiver to partnerships
- Application of the BEAT waiver election to consolidated groups
- Application of the BEAT to partnerships, with specific changes are related to:
- Effectively connected Income
- Partnership anti-abuse rules – derivatives involving partnerships
- Anti-abuse rules of Reg. Sec. 1.59A-9 for basis step-up transactions
Detailed guidance around how to do some BEAT calculations for groups of related taxpayers
Generally, a taxpayer and its affiliated corporations are aggregated for purposes of determining the gross receipts and the base erosion percentage if they are members of the same controlled group of corporations, as defined in section 1563(a) with certain modifications (including by substituting “more than 50 percent” for “at least 80 percent”). Where a taxpayer is a member of an aggregated group, the final regulations provide additional guidance regarding how to apply the gross receipts test and the base erosion percentage test. The additional guidance includes the following:
- Rules Relating to the Determination of Gross Receipts and the Base Erosion Percentage for a Short Taxable Year. The regulations provide that a taxpayer that is a member of an aggregate group measures the gross receipts and base erosion percentage of its aggregate group for a taxable year by reference to the taxpayer’s gross receipts, base erosion tax benefits, and deductions for the taxable year, and the gross receipts, base erosion tax benefits, and deductions of each member of the aggregate group for the taxable year of the member that ends with or within the taxpayer’s taxable year (the “with-or-within method”). Proposed regulations provided that a taxpayer with a short taxable year must use a reasonable approach to determine the gross receipts and base erosion percentage of its aggregate group members for the short taxable year and that a reasonable approach would neither over-count nor under-count the gross receipts, base erosion tax benefits, and deductions of the members of the 6 taxpayer’s aggregate group, even if the taxable year of a member or members of the aggregate group does not end with or within the short period. The final regulations clarify that when a member of an aggregate group does not have a taxable year that ends with or within a short taxable year of a taxpayer, excluding the gross receipts, base erosion tax benefits, and deductions of the member from the taxpayer’s aggregate group is not a reasonable approach.
- Close of Taxable Year Rule for Determining Gross Receipts and Base Erosion Percentage for Members Leaving and Joining an Aggregate Group. The proposed regulations provided guidance clarifying how the gross receipts and the base erosion percentage of an aggregate group are determined when members join or leave a taxpayer’s aggregate group, such as through a sale of the stock of a member to a third party. Specifically, the proposed regulations provided that, in determining the gross receipts and the base erosion percentage of a taxpayer’s aggregate group, only items of members that occur during the period that they were members of the taxpayer’s aggregate group are taken into account. To implement this cut-off rule and determine which items occurred while a corporation was a member of a particular aggregate group, proposed regulations treated a corporation that joins or leaves an aggregate group (in a transaction that does not otherwise result in a taxable year-end) as having a deemed taxable year-end. The proposed regulations provided that this deemed taxable year-end occurs immediately before the corporation joins or leaves the aggregate group (“time-of transaction rule”). The final regulations clarify that the deemed taxable year-end occur at the end of the day of the transaction, rather than immediately before the time of the transaction, to better align with other provisions of the Code and regulations. Thus, a new taxable year is deemed to begin at the beginning of the day after the transaction.
- Aggregate Group Members with Different Taxable Years Leading to Over-and Under-Counting of Gross Receipts. Due to a concern that the deemed close of the taxable year that occurs when a member joins or leaves an aggregate group would create the potential for over-counting of gross receipts, base erosion tax benefits, and deductions of a member when applied in conjunction with the with-or-within method, the final regulations adopt an annualization rule . This situation can arise when the taxpayer and a member of the aggregate group have different taxable years. Specifically, this rule provides that, if a member of a taxpayer’s aggregate group has more than one taxable year that ends with or within the taxpayer’s taxable year and together those taxable years are comprised of more than 12 months, then the member’s gross receipts, base erosion tax benefits, and deductions for those years are annualized to 12 months for purposes of determining the gross receipts and base erosion percentage of the taxpayer’s aggregate group. To annualize, the amount is multiplied by 365 and the result is divided by the total number of days in the year or years.
The final regulations also adopt a corresponding rule to address short taxable years of members. Specifically, if a member of the taxpayer’s aggregate group changes its taxable year-end, and as a result the member’s taxable year (or years) ending with or within the taxpayer’s taxable year is comprised of fewer than 12 months, then for purposes of determining the gross receipts and base erosion percentage of the taxpayer’s aggregate group, the member’s gross receipts, base erosion tax benefits, and deductions for that year (or years) are annualized to 12 months. This rule does not apply if the change in the taxable year-end is a result of the application of the consolidated return rule which provides that new members of a consolidated group adopt the common parent’s taxable year.
The final regulations also adopt a corresponding anti-abuse rule to address other types of transactions that may achieve a similar result of excluding gross receipts or base erosion percentage items of a taxpayer or a member of the taxpayer’s aggregate group that are undertaken with a principal purpose of avoiding applicable taxpayer status.
- Predecessors and Successors. Proposed regulations provided that, in determining gross receipts, any reference to a taxpayer includes a reference to any predecessor of the taxpayer, including the distributor or transferor corporation in a transaction described in section 381(a) in which the taxpayer is the acquiring corporation. To prevent over-counting, the proposed regulations provided that, if the taxpayer or any member of its aggregate group is also a predecessor of the taxpayer or any member of its aggregate group, the gross receipts, base erosion tax benefits, and deductions of each member are taken into account only once. The final regulations clarify that that a taxpayer will take into account gross receipts of foreign predecessor corporations only to the extent the gross receipts are taken into account in determining income that is effectively connected with the conduct of a U.S. trade or business (“ECI”) of the foreign predecessor corporation, which would be consistent with the ECI rule for gross receipts of foreign corporations in §1.59A-2(d). The final regulations also clarify that the operating rules set forth in §1.59A-2(c) (aggregation rules) and §1.59A-2(d) (gross receipts test) apply to the same extent in the context of the predecessor rule. Thus, the ECI limitation on gross receipts in §1.59A-2(d)(3) continues to apply to the successor.
Some rules allow taxpayers to waive deductions for purposes of the BEAT
For purposes of determining a taxpayer’s base erosion tax benefits and the base erosion percentage, the proposed regulations provided that all deductions that could be properly claimed by a taxpayer are treated as allowed deductions. However, if a taxpayer elected to forego a deduction and followed specified procedures (the “BEAT waiver election”), the proposed regulations provided that the foregone deduction would not be treated as a base erosion tax benefit. Generally, under the proposed regulations, any deduction waived pursuant to the BEAT waiver election is waived for all U.S. federal income tax purposes.). The final regulations provided include the following modifications and clarifications related to the BEAT waiver election:
- Eligibility for the BEAT Waiver Election. Proposed regulations provided that the BEAT waiver election is the sole method by which a deduction that could be properly claimed by taxpayer for the taxable year is not taken into account for BEAT purposes (the “primacy rule”). The final regulations clarify that, in order to make or increase the BEAT waiver election under §1.59A-3(c)(6), the taxpayer must determine that the taxpayer could be an applicable taxpayer for BEAT purposes but for the BEAT waiver election. Thus, for example, a controlled foreign corporation that does not have income that is effectively connected with the conduct of a trade or business in the United States cannot make a BEAT waiver election because the controlled foreign corporation cannot be an applicable taxpayer. In addition, the final regulations clarify that the BEAT waiver election should not affect any existing law addressing “waiver” outside of the specific situation covered by the BEAT waiver (electing not to claim a deduction in order to avoid applicable taxpayer status).
- Waiver of Life and Non-Life Reinsurance Premiums. The BEAT waiver election in the proposed regulations specifically referenced deductions and provided that the term “base erosion tax benefits” included certain reductions to gross income related to reinsurance that may be treated as reductions to gross receipts, not deductions. Because premiums that are reductions to gross income do not technically fit within the terminology used in the waiver provisions, comments to the proposed regulations requested that final regulations permit a waiver for those items. As a result, the final regulations include a provision for the waiver of amounts treated as reductions to gross premiums and other consideration that would otherwise be base erosion tax benefits within the definition of section 59A(c)(2)(A)(iii) and provide that similar operational and procedural rules apply to this waiver, such as the rule providing that the waiver applies for all purposes of the Code and regulations. The BEAT waiver election affects the base erosion tax benefits of the taxpayer, not the amount of premium that the taxpayer pays to a foreign insurer or reinsurer (or the amount received by that foreign insurer or reinsurer); therefore, for example, the waiver of reduction to gross premiums and other consideration (or of premium payments that are deductions for federal income tax purposes) does not reduce the amount of any insurance premium payments that are subject to insurance excise tax under section 4371.
- Partial Waivers. Proposed §1.59A-3(c)(6)(ii)(B) provided that, if a taxpayer makes the election to waive a deduction, in whole or in part, the election is disregarded for certain purposes. The final regulations have been revised to state more explicitly that a deduction may be waived in part. In addition, the IRS plans to revise Form 8991, Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts, to incorporate reporting requirements relating to the reporting of deductions that taxpayers have partially waived.
- Application of the BEAT Waiver Election to Partnerships. The final regulations expand the BEAT waiver election to permit a waiver in connection with deductions that are allocated from a partnership. In addition, subject to certain special rules in connection with the centralized partnership audit regime enacted in the Bipartisan Budget Act of 2015 (the “BBA”), the final regulations explicitly permit a corporate partner in a partnership to make a BEAT waiver election with respect to partnership items and clarify that a partnership may not make a BEAT waiver election. The final regulations also provide that waived deductions are treated as non-deductible expenditures under section 705(a)(2)(B).
Further, the final regulations clarify that, when a partner waives a deduction that was taken into account by the partnership to reduce the partnership’s adjusted taxable income for purposes of determining the partnership-level section 163(j) limitation, the increase in the partner’s income resulting from the waiver is treated as a partner basis item for the partner, but not the partnership. Thus, the increase in the partner’s income resulting from the waiver is added to the partner’s section 163(j) limitation computation and the partnership’s section 163(j) computations are not impacted by the partner’s waiver.
Finally, the final regulations clarify that a partner may make the BEAT waiver election with respect to an increase in a deduction that is attributable to an adjustment made under the BBA audit procedures, but only if the partner is taking into account the partnership adjustments either because the partnership elects to have the partners take into account the adjustments under sections 6226 or 6227, or because the partner takes into account the adjustments as part of an amended return filed pursuant to section 6225(c)(2)(A. If the partner makes the BEAT waiver election, the partner will compute its additional reporting year tax or the amount due under §301.6225-2(d)(2)(ii)(A), treating the waived amount as provided in §1.59A-3(c)(6).
- Application of the BEAT Waiver Election to Consolidated Groups. The final regulations clarify that waived deductions attributable to a consolidated group member are treated as noncapital, nondeductible expenses that decrease the tax basis in the member’s stock for purposes of the stock basis rules in §1.1502-32 to prevent the shareholder from subsequently benefitting from a waived deduction when disposing of the member’s stock.
Extra guidance on partnerships and anti-abuse rules
A.Application of the ECI Exception to Transactions Involving Partnerships. The 2019 final regulations set forth operating rules for applying the BEAT to partnerships. In general, the final regulations provide that a partnership is treated as an aggregate of its partners and, accordingly, deem certain transactions to have occurred at the partner level for BEAT purposes even though they may be treated as having occurred at the partnership level for other tax purposes. Generally, the 2019 final regulations provide an exception (the “ECI exception”) whereby a base erosion payment does not result from amounts paid or accrued to a foreign related party that are subject to tax as ECI. To qualify for the ECI exception, the taxpayer must receive a withholding certificate on which the foreign related party claims an exemption from withholding under section 1441 or 1442 because the amounts are ECI. The final regulations expand the ECI exception to apply to certain partnership transactions. The expanded ECI exception applies if the exception in §1.59A-3(b)(3)(iii)(A) or (B) would have applied to the payment or accrual as characterized under §1.59A-7(b) and (c) for purposes of section 59A (assuming any necessary withholding certificate were obtained). To implement this addition, the final regulations include modified certification procedures similar to those set forth in §1.59A-3(b)(3)(iii)(A) in order for the taxpayer to qualify for this exception. Specifically, the final regulations require a taxpayer to obtain a written statement from a foreign related party that is comparable to a withholding certification provided under §1.59A-3(b)(3)(iii)(A), but which takes into account that the transaction is a deemed transaction under §1.59A-7(b) or (c) rather than a transaction 37 for which the foreign related party is required to report ECI. The taxpayer may rely on the written statement unless it has reason to know or actual knowledge that the statement is incorrect.
B.Partnership Anti-Abuse Rules – Derivatives Involving Partnerships. The proposed regulations provide an exception from base erosion payment status for qualified derivative payments and define a derivative for purposes of the QDP rules as a contract whose value is determined by reference to one or more of the following: (1) any shares of stock in a corporation, (2) any evidence of 38 indebtedness, (3) any actively traded commodity, (4) any currency, or (5) any rate, price, amount, index, formula, or algorithm. Under an anti-abuse rule relating to derivatives on partnership interests and partnership assets, if a taxpayer acquires a derivative on a partnership interest or partnership assets with a principal purpose of eliminating or reducing a base erosion payment, then the taxpayer is treated as having a direct interest in the partnership interest or partnership asset (instead of a derivative interest) for purposes of applying section 59A. The final regulations provide that the partnership anti-abuse rule for derivatives does not apply when a payment with respect to a derivative on a partnership asset qualifies for the QDP exception. §1.59A-9(b)(5).
C.Anti-abuse Rules of §1.59A-9 for Basis Step-up Transactions. Section 59A(d)(2) generally defines a base erosion payment to include an amount paid or accrued to a foreign related party in connection with the acquisition of depreciable or amortizable property. However, §1.59A-3(b)(3)(viii) provides an exception to the definition of a base erosion payment for certain amounts transferred to or exchanged with a foreign related party in a transaction described in sections 332, 351, 355, and 368 (the “specified nonrecognition transaction exception”). The 2019 final regulations provided that if a transaction, plan, or arrangement has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a specified nonrecognition transaction, the nonrecognition exception of §1.59A-3(b)(3)(viii)(A) will not apply to the nonrecognition transaction. Additionally, the final regulations contain an irrebuttable presumption that a transaction, plan, or arrangement between related parties that increases the adjusted basis of property within the six-month period before the taxpayer acquires the property in a specified nonrecognition transaction has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a nonrecognition transaction.
Due to concerns that the anti-abuse rule can create a “cliff effect” whereby a minimal amount of pre-transaction basis step-up could disqualify an entire transaction that would have otherwise qualified for the specified nonrecognition transaction exception, the final regulations now provide that when the anti-abuse rule applies, its effect is to turn off the application of the specified nonrecognition transaction exception only to the extent of the basis step-up amount. In addition, the final regulations clarify that a transaction, plan, or arrangement with a principal purpose of increasing the adjusted basis of property must also have a connection to the acquisition of the property by the taxpayer in a specified nonrecognition transaction. This change was made out of concern that some taxpayers interpreted the prior version of the rule to potentially apply to certain basis step-up transactions (for example, a qualified stock purchase for which an election is made under section 338(g)), even if that basis step-up transaction had no factual connection with a later specified nonrecognition transaction (for example, the section 338(g) transaction occurred many years before the BEAT was enacted, but the property still has a stepped-up basis that is being depreciated or amortized when the subsequent specified nonrecognition transaction occurs).